History Lesson: Money in the United States

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First Bank of the US is formed in 1791 by Secretary of the Treasury, Alexander Hamilton.

The bank issued stock and bought dollars backed by individual states. This allowed the US to have its own currency for the first time. The charter lasted 20 years and was not renewed.

Second Bank of the US was formed in 1816.

This bank was formed in response to paying the debts of the War of 1812. It held tax revenues from the government and could issue its own notes. These notes weren't backed by anything and caused inflation. Andrew Jackson ended the bank in 1833 by issuing an executive order that allowed local banks to hold government revenues. The bank later went out of business. Money was backed by gold.

Various laws passed to force (or not allow) the government to buy silver from western mines. The goal was to cause inflation to help farmers pay off debts. Silver was pegged at 16 ounces to one ounce of gold.

William Jennings Bryan's Cross of Gold Speech at Democratic Convention in 1896.

Bryan ran for president on the idea that gold-backed money was good for the wealthy but not the poor and famers. He wanted inflation to bail out farmers.

US officially takes gold standard in 1900.

Banking Crisis of 1907.

Partially caused by the San Francisco earthquake of 1906 and the attempt to corner the stock of US Copper. JP Morgan (JPM) and John D. Rockefeller recapitalized banks. Run on banks ended.

Federal Reserve formed in 1913. Still on gold standard.

Stock market crash of 1929.

Stocks are run up due in part to a margin of 90%. That means a person only has to put up 10% of the value of a stock and the brokerage house loans the other 90%. If the investment drops 10%, the investor is in negative equity.

Great Depression.

Run on banks. People withdraw money and cause a downward spiral. There's no such thing as FDIC insurance and the Fed can do little to help. Can't print money because of gold standard.

Roosevelt devalues dollar by 57%.

It used to take only $20.67 to buy an ounce of gold. Took $35 to buy an ounce after Roosevelt passes law. Also enforces bank holiday and makes it illegal to send gold out of the country or to physically hold more than $100 worth of gold.

Bretton Woods System (1946).

US acquires much gold by selling munitions and weapons to European countries. Pegged gold at $35 to one ounce and then pegged foreign currencies to our dollar.

Nixon takes US off Gold Standard (1971) in part to pay for Vietnam War.

Our money supply had grown slowly until this point of time. In January of 1971, M3, the measurement of money, grew from $783 billion to a whopping $1.823 trillion in January 1980. Gold explodes in value from $35 to well over $800 in less than a decade.

Paul Volcker elected as Fed Chairman in 1979.

Money supply grows but Volcker lifts interest rates to over 20% to fight inflation. In the 1980s, for every two World War II generation workers to retire, three Baby Boomers step up and take their place (not exactly that ratio but you get the picture).

Greenspan and Bernanke rein: Money supply grows at 6% rate.

Not a problem for many years because of the huge Baby Boom generation and immigration. Fannie Mae (FNM) and Freddie Mac (FRE) make home loans with small amounts of money to use as a down payment. Banks hold very little capital in relation to money loaned. Banking system implodes and money is printed to bail out banks. For every Baby Boomer to retire, only one Generation X or Y steps up to take their place. No longer in a growth phase but money supply is still skyrocketing. M3 is no longer measured but is probably about $13 trillion. It was $1.8 trillion in 1980.

Conclusions:

Wars and the need to pay off government debt have always precipitated the printing of money.

Debt and margin have led to all busts. Thank God that the margin requirements for borrowing stocks are 50% now instead of 90%. Unfortunately, consumer debt is killing us now. Investors always find loopholes to borrow stocks.

Some printing of money is good -- to bail out bank customers. Too much printing has always and will always lead to inflation.

Do away with Fannie Mae and Freddie Mac. Home borrowers should go to local banks and put down 20% like in the old days. It would make housing affordable and dramatically reduce the number of foreclosures (in the future).

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